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Former inmate at Eastern State Penitentiary, William Harrison, 75, served 3 separate terms (1959, 1962, 1970) for larceny, forgery, and assault, and revisits his prison cell on the second level of block 14 in Philadelphia, Pennsylvania April 30, 2014. REUTERS/Mark Makela

Study Finds Private Prisons Offer Massive Cost Savings

Have researchers been underestimating the cost savings of privately run prisons? A recent report released by the Independent Institute says so.

Because states tend to omit indirect costs (such as administrative overhead) and underfunded pension obligations in their measures of avoidable costs, economists Simon Hakim and Erwin Blackstone claim, official estimates are often grossly understated.

Using data from 10 states — nine that already utilize contract prisons, plus Maine, which could contract out inmates to contract prisons in other states — the authors determine each state’s avoidable cost (that is, the amount that could be saved by contracting prisoners out) and compare it to the per-diem amount charged by private operators.

In determining the costs of private prisons, the authors begin with the per-diem rate that those prisons charge the state to house each prisoner, and then make adjustments to account for expenses not assumed by the private operator (in Kentucky, for instance, healthcare and prescription drugs for inmates in contract prisons are paid for by the state).

In the case of prisons that are owned by the state but managed by a private operator, the comparison is a straightforward one between the day-to-day (short-run) operating costs of private and state-run prisons. Prisons that are privately owned, however, must be measure against long-run avoidable costs, which also include the capital costs associated with building, maintaining, and modernizing prison facilities.

States that use contract prisons to reduce costs generally require minimum savings of between 5 percent and 10 percent, but only the most optimistic studies have found this to be in keeping with the average savings realized by states that use contract prisons (most have estimated average savings between 0 and 3 percent).

Blackstone and Hakim counter that this is only true in the short run, where they found an average savings of about 9.75 percent. However, when long-run expenses are the basis for comparison, as they are for seven of the 10 states in the study, average savings exceed 25 percent.

According to Hakim and Blackstone, “exposing public prisons to greater competition should lead to lower costs and improved performance of both public and private prisons,” because the threat of further privatization leads prison administrators to make more-determined efforts to reduce costs and induces public employees to temper their demands.

The competition created by contract prisons also reduces administrative overhead, because the profit motive creates a strong incentive toward managerial and technological innovation.

Finally, privately owned contract prisons relieve states of the burden of keeping up with fluctuation in demand. The number of inmates that a state needs to incarcerate varies over time, and significant costs are associated both with the building of new facilities during periods of high demand, as well as with the maintenance of unneeded facilities during periods of low demand.

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